Monday, April 19, 2010

On Friday, Goldman Sachs was charged by the Securities and Exchange Commission with fraud in the formation and marketing of a mortgage backed product, a so-called Collateralized Debt Obligation.

The gist of the allegations is that Goldman Sachs failed to disclose that a major hedge fund both helped in the selection of the mortgages to be included in the CDO and took a short-position against the CDO, thereby betting it would fail. In newspaper headline lingo, the product was doomed to fail to benefit a Goldman Sachs client.

The case is not as open and shut at the newspapers headlines make it seem. The theory is something of a test case based on the failure to disclose risks which the sophisticated institutional purchasers allegedly should have understood:

The SEC's case against Goldman and a vice president at the firm, Fabrice Tourre,hangs on a single critical contention. The SEC says Goldman sold investors a product linked to the performance of certain mortgages without telling them that a hedge fund betting on the mortgages' demise helped design the product.

Several lawyers not involved in the case said the evidence, as laid out in the SEC's complaint, is deep enough to support the civil fraud charges. "From the complaint, it looks pretty strong," said Jill Fisch, a law professor at the University of Pennsylvania. "It's a test case in terms of the SEC going forward both for whether they're successful and, if they settle, will it be a meaningful penalty," she said.

The allegations are serious, but there is an equally serious question: Why now?

Allegations that Goldman Sachs "bet against clients" have been around for months, and led to a fairly spirited denial. The charges could have been brought weeks ago, or weeks from now, and there would have been no difference to the cause of securities regulation.

Is it coincidence that suit was brought just as the Obama administration and Chris Dodd were rolling out financial services reform with a quick vote planned in the Senate?

Call me a skeptic. But skepticism is warranted whenever this administration claims crisis, as in the phony "crisis" which led to the ramming through of the Stimulus Plan before anyone could read it, and the health care "crisis" which required repeated phony deadlines followed by extraordinary measures including payoffs to Senators and budget reconciliation.

Having created or found a crisis, the Obama administration is in full campaign mode to push sweeping financial regulation through Congress on another party-line vote, if it can pick off one Republican Senator. Hence, the push is on to ratchet up public pressure using Goldman Sachs as an excuse.

On Saturday, Obama made financial industry reform the focus of his weekly radio address, using the language of crisis (emphasis added):

"The consequences of this failure of responsibility -- from Wall Street to Washington -- are all around us: 8 million jobs lost, trillions in savings erased, countless dreams diminished or denied, " Obama said. "I believe we have to do everything we can to insure that no crisis like this ever happens again."

Over the weekend the Obama public relations machine began sending out e-mails again invoking the alleged crisis (emphasis mine):

It has now been well over a year since the near collapse of our entire financial system that cost the nation more than 8 million jobs. But the flaws in our financial system that led to this crisis remain unresolved.

Wall Street titans still recklessly speculate with borrowed money.

We cannot delay action any longer. It is time to hold the big banks accountable. Arm-twisting lobbyists are already storming Capitol Hill, seeking to undermine the strong bipartisan foundation of reform with loopholes and exemptions for the most egregious abusers of consumers.

It's a fight worth having, and it is a fight we can win -- if we stand up and speak out together.

So far, all 41 Republican senators have signed a letter opposing reform -- but there is still time for individual senators to do the right thing.

Thank you,

President Barack Obama

The Goldman Sachs suit explicitly is being used as the main talking point to overcome Republican objections to the current form of the bill (emphasis mine):

Goldman Sachs case could help Obama shift voter anger‎: "Fraud charges leveled against the investment bank Goldman, Sachs & Co. center on complex financial dealings. But for President Obama, the accusations against the venerable Wall Street institution offer a chance to revitalize a simple political narrative that he has all but lost in recent months: that he and his party are protecting ordinary Americans victimized by the economic meltdown."

Democrats Seize on Oversight‎: "With the Senate scheduled to begin debate on a financial overhaul bill this week, the fraud lawsuit against the Wall Street titan Goldman Sachs has emboldened Democrats to ratchet up pressure on Republicans who oppose the Obama administration’s proposal."

Goldman Suit Harnessed for Internet Ad Campaign: "President Barack Obama’s political advisers are trying to harness the government’s case against Goldman Sachs Group Inc. to build support for a financial- markets overhaul pending in Congress. A Google Inc. search of “Goldman Sachs SEC” yields an advertisement entitled “Help Change Wall Street” that is sponsored by Organizing for America, Obama’s official political arm outside the White House."

We've been here before. No crisis is allowed to go to waste, and if there is no crisis, create one. And at all times, find an enemy against whom to campaign.

The suit against Goldman Sachs may have merit, or it may not. We will not know for a while. In the meantime, this administration will use the "crisis" for its own political purposes and isolate and demonize an enemy, as it always does.

Once the administration gets the legislation it wants, the actual "crisis" will be but a distant memory, a mere detail on the road to sweeping regulation which no one will understand at the time of the vote, and which will have untoward unintended consequences which will last for decades.

The timing of the Goldman Sachs suits smells. And with this administration, where there's a smell, it stinks.

13 comments:

"The timing of the Goldman Sachs suits smells. And with this administration, where there's a smell, it stinks."

Fantastic post! Everything about this guy, and this administration, stinks. Alinsky-style stinks. It is all, as you outline, just too coincidental, too convenient. The "Blame it on Wall St." card is being played - again. Just as it was in 2008.

I have always believed the October 2008 financial meltdown was ginned-up - just as now, it could have been exposed earlier or later. But it was all exposed JUST when McCain/Palin were up in the polls, looking like they had momentum. Always question the timing with these Chicago-style Alinsky-ite thugs.

Also, Goldman-Sachs was probably lulled into believing they were "protected" from this type of attack, since they were deemed "too big to fail"...... But, as the saying goes, "With friends like these (the Obama/Reid/Pelosi admin.) who needs enemies?!"

Professor, just to put this timing issue into perspective, I am going to pose to you the same deal I posed to Dan Rhiel:

You hire me to advise you on putting together a baseball team that will have a chance to be in the World Series and paying me a fee of $15 million for my services.

You also insist that I hire an expert consultant to pick the players.

Without telling you, I select George Steinbrenner as the consultant and without telling you, I place a bet against you that eventually earns me a billion dollars in winnings.

Question: When is the best time for you to sue me?

Answer: When you have the best likelihood of winning.

Or is it when you can win without the taint of ulterior political motives?

What Goldman did may not be illegal but it speaks volumes about what is wrong with Wall Street and these post Glass-Steagall Act "too big to fail" three card monte operations need to be shut down.

There are no good guys here. The Republican solution is even worse than the Democratic solution on the table. On the other hand, William Kristol came around yesterday to admitting that these banks should be broken up. Let's just do it and stop haggling over timing.

No one would ever believe for a second that Goldman Sachs is a victim here. It is more likely that they have too much control over government policy and lax regulation.

Let's wait and see how this unfolds. The Dem solution stinks but the Reps is even worse. At the moment, their differences can be reduced to whether the $50 billion automatic bailout fund will survive this bill. It won't. But this bill is NOT about breaking up the "too big to fail" banks and the Republicans are even more adamantly against breaking them up.

We need to re-instate Glass-Steagall and there were signs over the week-end that the Republicans are coming around to this. Besides Bill Kristol's u-turn on Fox Sunday News, Juan McCain himself opened the same program suggesting just that: re-instate Glass Steagall. This is a big (and very welcome for me) flip-flop by the GOP.

Perhaps the best non-Democratic approach is to let them have enough rope to hang themselves with. Let the Dems get all lathered up, impose draconian new regulation (on their political contributor financial sector buddies!)and let's see what happens to the economic "recovery."

Seems to me the last time you'd want to be doing intrusive medical research is on a patient who just barely survived the last round of surgery.

The Republicans should spend a lot of time laying a record for "I told you so", and then sit back and let the Dems run amok. We'll look back at the Dems as the party to create the Great Depression II.

Your analogy is good but flawed. In your situation I hire you to put together a baseball team and win the world series. To actually mirror the Goldman Sachs situation, you would then say that an outside consultant would be involved in the player selection process. You hire Steinbrenner and he makes a selection of 25 players for the roster. Then, you would come to me, tell me who the outside consultant is, tell me who the players he picked are, and then allow me to personally change any of the 25 players that I want. Oh, and "I" am Theo Epstein of the Boston Red Sox. I change half of them to different players. You; however, fail to tell me that Steinbrenner's other baseball team will be competing against my baseball team. In fact, you had one of your assistance tell me that Steinbrenner's team is going to beat other teams to help me when the division.

My analogy is only flawed if you assume that I would disclose to you who my independent outside expert is. You can assume I didn't because Goldman didn't disclose their relationship with Paulson and my example parallels the Goldman case. So you are actually making my case for me.

Even had Goldman not placed a major bet against the client, no one would have agreed to this deal had they known that Paulson structured the deal.

At the moment, neither party has a sensible solution and yet we are bogged down in foolish partisan arguments. This bill needs to be killed because the Republicans have no alternative to offer.

Investments are not baseball. This case has twists and turns that even politicians will find to be be overly complex. First of all, the case against Goldman is weak. Although Paulson was involved in selecting the CDO, they were not ultimately responsible for picking the portfolio. That job fell to ACA, who took suggestions from Paulson, but ultimately made the selections ...and by the way, ACA was the principal investor in the Abacus CDO.

Since GS execs contributed over one million dollars to the Obama campaign and the financial people hired on by the Obama administration were largely ex-GS, it is easy to predict that one Goldman Sachs VP will be thrown under the bus and the mess will be swept under the rug immediately after the new Wall Street legislation, complete with its permanent bailout provision, is presented to the president for signature.

Goldman earned a commission of $15 million from the client filing the complaint. They earned a billion dollars betting against the client. Whether talking investments or baseball, that's a big stinking matzo ball just hanging in public view.

The "investments are not baseball" defense may make the legal case for Goldman but it won't make the public image case. It doesn't help them to argue that cheating one's clients is legal. This is the perfect example of what is wrong with investment banks trading through their own proprietary trading desks for their own accounts using inside information provided to them by their clients that no one else has access to including the clients on all sides of the trades.

There is no escaping the obvious fact that the current unregulated casion-style Wall Street is an economy killer.

The Goldman Sachs thing is world wide. I have to go back and read the articles, but investigations are under way in other countries especially in Germany. Goldman Sachs did some illegal things concerning Greece and their huge deficit that was hidden from the European community.

It could be that the charges have been timed to fit perfectly with the push for this control of Wall Street. If that is the case then the legislation should be vigorously opposed.

Besides, I tend to believe that the person who should be charged for crimes committed is George Soros.

Well, I have to give credit to the Democrats on this one- I thought taking over 1/6 of the US economy through reconciliation would be the low-point. But they've outdone themselves here.

This is pure, unadulterated kabuki here. Think about it: say Goldman Sachs is deemed liable and ultimately has to pay a "fine" (some estimates I've seen are around $100M). Who's REALLY going to be paying that fine? WE are. Why? Just follow the money: Fed lends at all-time low rates to GS and the other big banks, GS then purchases US t-bills (instead of lending to small businesses), and pockets the difference, making billions in "investing" profits (and btw, recent 12/09 Fed H.3 data shows that excess reserves soared from $2 billion in 8/08 to over $1 trillion, as of 11/09). Any "fine" would simply be the government's own money funneled back to them.

And pasadenaphil, as for the problems of "deregulation"- you might want to check again who signed into law the repeal of Glass-Steagall. Further, we've had increased regulation since Sarb-Ox- some good that did. The SEC apparently knew about the Stanford ponzi scheme since 1997; it had been warned about Madoff for years- and what did they do about it? And if this is such a "crisis" then Obama just put the entire US financial system at risk for the past year by not addressing this sooner when he was spending all of his time on health care (many provisions of which will not go into effect until years to come).

And unfortunately, a deeply troubling problem that will surely never be addressed by the foxes (Dodd, Conrad, etc.) guarding the hen house: as the WSJ notes, "New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A... It is easy to see how this misrepresentation was a principal cause of the financial crisis." The punishment? Instead of shutting down Fan and Fred, they get an unlimited bailout on Christmas Eve.

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